Retirees are often caught off guard by the realities of transforming their savings into real, long-lasting income in retirement. Accumulating wealth takes discipline and time, but distributing it sustainably requires precision, skill, tax planning, and forecasting.
You can build savings for retirement through all market conditions. Better market performance may increase returns, while poor performance can provide tax-focused opportunities to rebalance. Withdrawing during a market downturn, however, can amplify market losses across the span of retirement. This is called sequence of return risk. The sooner it happens in retirement, the more impactful it becomes, even if a full market recovery occurs later.
Sequence of returns risk is powerful, and it can’t be easily reversed. It can, however, be considered within your retirement income strategy. In fact, sequence of returns risk is the core problem the bucket strategy is designed to solve. That’s why our team at Provision Wealth Planning prefers the bucket strategy for structuring retirement income and protecting our clients’ portfolios against potential market downturns (particularly during the earliest stages of retirement).
What Is the Bucket Strategy?
The bucket strategy is a common retirement income strategy that divides retirement resources into three distinct categories (or buckets):
Short-Term (Bucket One): The funds in bucket one are designed to be your most liquid assets, namely, cash and cash equivalents. These are funds you can easily access through your checking or savings account. The short-term bucket should be used to cover your immediate living expenses, usually up to one or two years. Since this bucket is primarily comprised of cash, it’s never at market risk.
Medium-Term (Bucket Two): The funds in bucket two are intended to be accessed within the next three to five years (though you can create your own bucket parameters). Because these funds have a little longer to grow and recover from a potential downturn, they can retain a small amount of risk. Bucket two commonly consists of bonds, stable-value funds, or other lower-volatility assets.
Long-Term (Bucket Three): Bucket three holds growth-oriented investments, which are meant to remain invested for six years or longer. Because you won’t be touching these assets for quite some time, they have more opportunity to build wealth and recover from potential downturns.
As one bucket gets depleted, the funds from the next bucket flow into it like a waterfall. Each bucket’s specific timeline and allocations will need to reflect your own risk tolerance, income sources, and tax situation.
The bucket strategy can offer a greater level of financial security, particularly during a market downturn. You can continue spending confidently from bucket one, without worrying too much about what’s happening in bucket three. When market volatility feels less like an emergency, you feel less pressure to make reactive, or potentially costly, decisions in retirement.
How to Build Your Buckets Before You Retire
The bucket strategy is most effective when implemented before retirement begins rather than waiting until after a market downturn has occurred.
To start building your buckets, consider what your annual spending needs will likely be in retirement. This can be a rough estimate based on your existing spending habits, goals for retirement (travel, moving cities, downsizing, etc.), and any major anticipated changes to your lifestyle. As a general rule of thumb, you should expect to spend between 55% and 80% of your pre-retirement income in retirement.1
With a number in mind, identify your guaranteed income sources for retirement. This might include Social Security benefits, a pension plan, or TIAA annuity payments.
There will likely be a gap here between how much you anticipate spending in retirement and what your guaranteed income sources will provide. That’s the amount you’ll be pulling from your retirement savings, using the bucket strategy.
Let’s consider Patricia, a recently retired UMaine librarian.
After reviewing her budget, Patricia needed about $80,000 annually to support her lifestyle in retirement. Between Social Security and a TIAA annuity election, she expected roughly $50,000 of guaranteed annual income. This left a $30,000 annual income gap.
Before retiring, Patricia began building her buckets. In bucket one, she put two years' worth of cash reserves, or $60,000. These funds lived in her high-yield savings account and checking account. She then allocated an additional three years’ worth of withdrawals into bucket two, before placing the remainder of her retirement assets into the third bucket for long-term growth.
Patricia entered retirement knowing she had several years of planned income available without needing to sell growth investments during a market downturn. That much-needed breathing room helped make the transition to retirement much less stressful overall.
How TIAA Distributions Fit Into the Bucket Framework
University employees often retire with substantial assets inside their TIAA 403(b) plans. Depending on your elections, TIAA assets may provide income through annuity payments, systematic withdrawals, or a combination of both.
Annuity income functions similarly to a paycheck. Because payments arrive on a predictable schedule, they can be incorporated into the first bucket and reduce the amount of cash reserves needed.
Systematic withdrawals offer greater flexibility but require ongoing monitoring since it’s easier to withdraw more than intended.
Your TIAA distributions will also need to be coordinated with your Social Security claiming strategy. Drawing modestly from retirement accounts and delaying Social Security, for example, can increase future guaranteed income while potentially creating tax planning opportunities during the early retirement years.
Of note, TIAA elections can be difficult (even impossible) to reverse once made. Before selecting a distribution option, carefully consider how each choice affects your broader retirement income strategy.
Balancing Your Buckets Over Time
Unfortunately, your buckets won’t run entirely on autopilot. Over time, withdrawals, market performance, and a change in your spending patterns will require periodic adjustments.
Your first bucket will need to be replenished from bucket two as cash reserves are spent. During strong market environments, gains from bucket three can be harvested to refill bucket two. In moments when the markets are performing poorly, the funds in bucket three can remain intact. This way, they’ll have an opportunity to (hopefully) recover before withdrawals become necessary.
Tax planning is an important consideration here as well. The bucket strategy enables you to withdraw from your taxable accounts first, before tapping into tax-deferred income from traditional IRAs and 403(b)s. Your most tax-efficient income, like Roth accounts, is used last to preserve tax efficiency over time.
Keep in mind, your withdrawals can impact your Modified Adjusted Gross Income (MAGI). As your income creeps higher, you become susceptible to Medicare’s Income-Related Monthly Adjustment Amount (IRMAA) surcharge. IRMAA increases Medicare premiums for those above the annually-adjusted MAGI thresholds.
Ready to Implement the Bucket Strategy into Your Retirement?
The first few years of retirement are often the most financially vulnerable, thanks in large part to sequence of returns risk. Having a withdrawal strategy in place before transitioning to retirement is an effective way to implement safeguards and increase financial stability throughout retirement.
If you're preparing to retire or have recently retired, there’s no time like the present to review your withdrawal strategy. Before making TIAA elections or claiming Social Security benefits, consider meeting with our founder, Thomas Harnish, AIF®, to map out a personalized bucket strategy designed around your goals, income needs, and long-term retirement vision.
Sources:
